What is a financial statement?
UNDERSTANDING THE NUMBERS: A BASIC EXPLANATION OF HOW MONEY WORKS
As a business owner, if you can understand accounting terminology, or simplify it to your understanding, numbers can be manageable.
Imagine this scenario: you walk into the bank to apply for a business property loan and the banker sits down with you to explain that the borrowing rate is at prime plus 1% and asks whether you want a fixed or fluctuating interest rate? You look at the banker dumfounded.
Sadly many business owners are in this position and it’s surprising how an entrepreneur can run a business without understanding the basics of how money works.
I agree, financial accounting is complicated, but if you’re in business you have to learn a thing or two about interest rates, overdrafts and liabilities, because it’s fundamental to the running of your business. The complexities of accounting, however, lie in the jargon and if you can understand the terminology – or better yet simplify it to your understanding – then numbers can be manageable. Over and above that your objective is not to learn the entire financial accounting syllabus, but to be in a position to read and understand a financial statement.
A financial statement informs you of the performance and financial health of your business. It does so through four statements: a profit or loss statement, balance sheet, cash flow statement and statement of equity change – although the statement of equity change is rarely used in small- or privately-held businesses.
A profit or loss statement adds all the revenue then subtracts all the expenses to tell you whether you made a profit or loss, also known as the bottom-line.
A balance sheet informs you of the health of your business through valuing all your assets, liabilities and ownership equity. Assets are for example equipment, property, cash, inventory and accounts receivables; liabilities comprise money owed to creditors for equipment or property bought on loan; and finally ownership equity which sometimes is referred to as the book value of the company, because assets minus liabilities is owners equity.
A cash flow statement is essentially concerned with the flow of cash in and out of the business; it does this by analysing the operating, investing and financing activities of the business.
When all is said and done the key is to break down accounting to terms and methods you understand. No one said you have to say “gross margin”; if you prefer saying “the difference between how much I sold it for and how much it cost to produce”, then by all means do so.